Few small business taxation matters have provoked as much controversy as the
Arctic Systems case. This legal battle has frustrated a vast number of
businesses across the UK. At the same time, the behaviour of HM Revenue &
Customs has proved an added concern for many advisers.

But the battle is now over, in favour of Geoff and Diana Jones of Arctic
Systems.

Lords found by 5-0 that the share of the company purchased by Diana Jones was
indeed a ‘gift’, and as such the transaction did not fall under laws that made
the company’s income as wholly taxable through the husband,

Arctic won the previous round of the case, in the Court of Appeal, in
December 2005. The case, a Section 660A appeal, revolved around the tax
regulator’s objection to the way the Jones’s used their salaries and dividend
payments to reduce their joint tax bill.

In 2005 the decision was hailed by Professional Contractors Group (PCG)
chairman Simon Juden as ‘the best Christmas present for the UK’s small family
businesses’.

Geoff Jones added: ‘This is the end of three years of uncertainty for us – at
one point we thought we’d lose our home. It’s been extremely stressful and we’ve
been made to feel like criminals, just for running our own business. What’s
more, by organising our affairs in this way, we were simply following government
advice and that of our accountants.’

The PCG supported the couple in its fight through the courts. That decision
in the Court of Appeal had followed a long and expensive trip through the
tribunals and the High Court, and Arctic lost the cases on both occasions,
finally winning the final showdown in the House of Lords.

The case has been particularly expensive because HMRC refused to pay both
sides of the court costs, as it usually would with a small business test case.

Controversially, HMRC appeared to rake up old tax rules to deal with a new
problem. The Joneses had structured the payment of dividends and income to
ensure that the two made the full use of their available allowances.

HMRC argued that the Joneses’ move did not have an effect for tax purposes,
since this was a ‘settlement’ under rules from the 1980s and the income Diana
received was still, in essence, Geoff Jones’ income.

The Joneses initially risked bankruptcy as a result of the claim, until HMRC
admitted it did not have the papers to pursue the full retrospective demand of
£42,000.

The threat has constantly existed that the government could pass legislation
saying explicitly that it is illegal.

That could be difficult, Kevin Nicholson, UK head of enterprise and private
companies and clients at Pricewater-houseCoopers said in 2006: ‘HMRC could bring
in new legislation, but I can’t see how they will do this. It would have to come
up with a new way of taxing husband and wife businesses, because fiddling with
existing law would be very complicated.’

Mar 2005 – landmark tax case appealed
at the High Court. The section 660A appeal revolves around HMRC’s objection to
the way the couple used their salaries and dividend payments to reduce their
joint tax bill